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Accounting. Prof: Jim Wallace TA: Charles Yeh. Overview of Week 1. Administrative stuff What is financial accounting? Financial statements GAAP What number do you want?. Administrative Stuff. Who am I Who is your T.A. Teaching philosophy Syllabus Homework Calculator.

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Prof: Jim Wallace

TA: Charles Yeh

overview of week 1
Overview of Week 1
  • Administrative stuff
  • What is financial accounting?
  • Financial statements
  • GAAP
  • What number do you want?
administrative stuff
Administrative Stuff
  • Who am I
  • Who is your T.A.
  • Teaching philosophy
  • Syllabus
    • Homework
  • Calculator
web access to class info
Web Access to Class Info
  • The site should contain:
    • Syllabus
    • PowerPoint slides
    • Handouts
    • Homework solutions
what is financial accounting
What is Financial Accounting?
  • A method to communicate financial information to interested external parties.
  • Users include capital providers, regulators, customers, suppliers, employees, etc
      • Capital suppliers include debt and equity providers
  • Financial accounting is used for both prediction and control
some preconceptions misconceptions
Some Preconceptions- Misconceptions?
  • Accounting yields the “truth.”
  • Accounting is rigid.
  • Accounting is useless.
  • Accounting is hard!
  • Accountants are boring.
other types of accounting
Other Types of Accounting
  • Managerial
  • Non-profit
  • Tax
the financial statements
The Financial Statements
  • The accounting equation
  • Balance Sheet
  • Income Statement
  • Statement of Cash Flows
  • Statement of Owners Equity
    • Statement of retained earnings
balance sheet
Balance Sheet
  • Mirrors the Accounting Equation

Assets = Liabilities + Equity

Uses of funds = Sources of funds

  • Assets are listed in order of liquidity
    • Current and non-current
  • Liabilities are listed in order of maturity
  • Equity consists of Contributed Capital and

Retained Earnings


To be reported on a balance sheet, an asset must:

  • Be owned or controlled by the company
  • Must possess expected future benefits
most assets are reported at historical cost
Most Assets are Reported at Historical Cost
  • Historical Cost is
    • Objective
    • Verifiable
    • Therefore, not subject to bias
  • However, historical cost is not particularly “relevant” to most readers of the balance sheet
  • “Relevance vs. Reliability” is an important issue with accountants.
  • Liabilities are listed in order of maturity
    • Current Liabilities come due in less than a year.
    • Noncurrent liabilities come due after a year.
  • Companies desire more current assets than current liabilities – this difference is called net working capital

Equity consists of:

  • Contributed Capital (cash raised from the issuance of shares)
  • Earned Capital (retained earnings). Retained Earnings is updated each period as follows:
market value vs book value
Market Value vs. Book Value

Stockholders’ equity = Company book value

  • Book value is determined using GAAP.
  • Book value is not the same as Market Value.
  • Market Value = # of Shares x Price per share
  • On average, US company book value is roughly two-thirds of market value.
accrual accounting
Accrual accounting refers to the recognition of revenue when earned (even if not received in cash) and the matching of expenses when incurred (even if not paid in cash).Accrual Accounting
accrual accounting20
Accrual accounting rests on two guiding principles:

Revenue Recognition Principle – record revenue when


Realized or Realizable

Matching Principle – record expenses when


Neither the recognition of revenue nor the recording of expense necessarily involves the receipt or payment of cash

Accrual Accounting
statement of stockholders equity
Statement of Stockholders’ Equity
  • Statement of Equity is a reconciliation of the beginning and ending balances of stockholders’ equity accounts.
  • Main equity categories are:
    • Contributed capital
    • Retained earnings (including Other Comprehensive Income or OCI)
    • Treasury stock
statement of cash flows
Statement of Cash Flows
  • Statement of cash flows (SCF) reports cash inflows and outflows
  • Cash flows are reported based on the three business activities of a company:
    • Operating activities: transactions related to the operations of the business.
    • Investing activities: acquisitions and divestitures of long-term assets
    • Financing activities: issuances and payments toward equity, borrowings, and long-term liabilities.
articulation of financial statements
Articulation of Financial Statements
  • Financial statements are linked within and across time – they articulate.
  • Balance sheet and income statement are linked via retained earnings.
  • Absent of equity transactions such as stock issuances and purchases and dividend payments, the change in stockholders’ equity equals the income or loss for the period.
in class example
In Class Example
  • Baron Coburg
oversight of financial accounting
Oversight of Financial Accounting
  • GAAP
  • Oversight of Financial Accounting
    • SEC oversees all publicly traded companies
  • Financial Accounting Standards Board (FASB)
    • Generally Accepted Accounting Principles (GAAP)
basic assumptions and principles
Basic Assumptions and Principles
  • Monetary Unit
  • Fiscal period
  • Going concern
  • Objectivity (Reliability)
  • Consistency
    • Versus comparability

Financial statements must contain objective and verifiable numbers if they are to be useful. Yet, many estimates and subjective assumptions are required for the preparation of these reports. Please reconcile these apparently inconsistent statements.

exception to the basic principles
Exception to the Basic Principles
  • Materiality
    • Only transactions with amounts large enough to make a difference are considered material
    • Non-material transactions can be treated in the easiest manner
information beyond financial statements
Information Beyond Financial Statements
  • Management Discussion and Analysis (MD&A)
  • Independent Auditor Report
  • Financial Statement Footnotes
audit report
Audit Report
  • Financial statements present fairly and in all material respects company financial condition.
  • Financial statements are prepared in conformity with GAAP
  • Financial statements are management’s responsibility. Auditor responsibility is to express an opinion on those statements
  • Auditing involves a sampling of transactions, not investigation of each transaction
  • Audit opinion provides reasonable assurance that the statements are free of material misstatements
  • Auditors review accounting policies used by management and estimates used in preparing the statements

The SEC requires all publicly traded companies to have their financial statements audited. Prior to this requirement many companies voluntarily had their statements audited. Given the cost and inconvenience, why would they do this?

what number do you want
What Number Do You Want?
  • Accounting is a political process, not an exact science.
  • There is a great deal of discretion available to managers.
earnings management
Earnings Management
  • Reasons to manage earnings
earnings management why
Earnings Management - Why
  • Compensation contracts
  • Debt contracts
  • Political considerations
transaction analysis
Transaction Analysis
  • Transaction analysis is the process of identifying impacts of transactions and events on the balance sheet, income statement, or both.
  • We use the following template:
  • Financial statements that are produced are the result of one possible set of rules that have resulted from a political process.
  • Users need to be aware of these limitations.
  • Users should read the notes to the financial statements since these contain a lot of useful guidance to interpreting the statements.
financial statement limitations
Financial Statement Limitations
  • Assets are valued at historical cost less an estimated depreciation
    • Other possibilities include cost, net realizable value, replacement cost, price level adjusted
  • Not all assets appear
    • Human capital, internally generated goodwill
      • Could be argued that approach is more conservative
financial statement limitations48
Financial Statement Limitations
  • Not all liabilities appear
    • Contingencies appear only in the footnotes
    • Off balance sheet financing
  • Other limitations include management biases and a lack of timeliness
financial accounting not an exact science
Financial Accounting: not an exact science
  • GAAP allows companies choices in preparing financial statements (inventories, property, and equipment).
  • Financial statements also depend on countless estimates.
financial accounting in context
Financial Accounting in Context
  • A company’s financial statements only tell part of the story.
  • You must continually keep in mind the world in which the company operates.
  • Financial statement analysis must be conducted within the framework of a thorough understanding of the broader forces which impact company performance.